Asset Class: U.S. Fixed Income

February 2019 Fixed Income Market Update

Economic and market perspective

The partial U.S. government shutdown that began in December was finally resolved on a temporary basis in January after 35 days. It was the longest government shutdown in U.S. history, during which approximately 320,000 Federal workers were furloughed. This impact is expected to be felt in U.S. first quarter GDP by as much as 0.4% according to the Congressional Budget Office. The short-term fix provides funding through February 15, bud did not address the major issues dividing President Trump and the Democratic held Congress, setting up the potential for a repeat.

U.S. consumer confidence declined to 120.2 from 126.6 in December, a greater than expected decline, according to the Conference Board. This figure is the lowest in a year and a half, though recent figures have been at 18 year highs. Also in the report, the percentage of people expecting business conditions to soften was at the highest level since 2013, following the last major government shutdown. In terms of labor market expectations, the difference between participants saying jobs were plentiful as opposed to difficult to find remained near the highest levels in 18 years.

Brexit drama continued with a resounding (but expected) defeat of Theresa May’s Brexit plan in British parliament. The set timeline for Brexit is growing short absent a postponement, but parliament voted to force the prime minister to renegotiate the Brexit deal with the E.U. Renegotiation of the deal was quickly rejected by the E.U.

For December, Chinese Producer Price Index (PPI) rose 0.9% for the trailing year versus the expectation of 1.6%. This was the latest in a series of disappointing economic data points coming from China, which has raised concerns about the impact to the global economy. Trade tensions with the U.S. persist, leading to another round of high level trade talks. Chinese President Xi Jinping indicated he would like to resolve the dispute by March 1. Criminal accusations against Huawei Technologies added to tensions in the month. In response to the continued trade tensions and softening data, the People’s Bank of China cut reserve ratios by 1%, with speculation that more easing may be needed.

Only a month after the European Central Bank (ECB) announced it would officially end its purchase of new assets in December 2018, ECB President Mario Draghi said that all policy tools would be available to support the European economy, including reinitiating a bond buying program. His comments reflected concerns around trade tensions, Brexit and slowing growth in Europe. For example, German industrial output fell 4.7% in November for the past year, the worst result since 2009 and European core CPI remained at 1%.

After the Fed’s comments in December around the rate hike were poorly received, Fed Chairman Powell made more dovish comments on January 10 to the Economic Club of Washington. These comments included restating the patience and data-dependency of the Fed and importantly more flexibility regarding the unwinding of the Fed’s balance sheet. Perceptions around the inflexibility of the Fed regarding the balance sheet unwind were blamed for the market’s reaction after the prior Fed meeting.

The Federal Open Market Committee met on January 29-30th and, as expected, announced no change in the Fed Funds Rate range of 2.25% – 2.50%. The Fed removed language referring to “further gradual increases” suggesting a slower approach to normalization and reinforced by their statement that “in light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal fund rate may be appropriate to support these outcomes.” The Fed also indicated they expect to maintain “an ample supply” of bank reserves, suggesting a higher terminal value for the balance sheet. As of January 31, Fed Fund Futures project at 0% probability of any rate hikes in 2019.

Outlook and conclusions

In our view, the return of market liquidity at the outset of the year and the market realization of the overreaction in December were more impactful than recent economic and geopolitical events. On balance, economic data weakened during the month, prior to the strong data at the outset of February, though at least in the U.S. the data was coming off of a strong base such that current figures are still robust. Outside of the U.S. the data is weaker; in both the U.S. and internationally, geopolitical and fiscal policy concerns remain. These concerns are likely to persist and with them volatility. On balance though, the recovery of risk assets leaves markets more fairly valued than a month ago, but we believe there is still room for markets to recover further. Broad bond yields remained above 3.1%, reflecting both modestly lower interest rates and tighter corporate and mortgage spreads. The opportunity set in non-governmental fixed income remains robust and overall yields for broad U.S. fixed income remain attractive.

 

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